The World’s Going Renewable. So Why Are Renewable Energy Stocks Getting So Little Love?

The World’s Going Renewable. So Why Are Renewable Energy Stocks Getting So Little Love?
Reda Farran, CFA

over 2 years ago4 mins

  • Renewable energy stocks are benefiting from massive infrastructure spending plans and improving investor sentiment, and they’re cheap relative to their growth potential.

  • But it’s important to view these stocks as long-term investments, and to be selective about which stocks you invest in.

  • To help you do that, you can screen for the stocks that are fundamentally strong and relatively cheap.

Renewable energy stocks are benefiting from massive infrastructure spending plans and improving investor sentiment, and they’re cheap relative to their growth potential.

But it’s important to view these stocks as long-term investments, and to be selective about which stocks you invest in.

To help you do that, you can screen for the stocks that are fundamentally strong and relatively cheap.

Mentioned in story

Renewable energy stocks have fallen out of favor after a stellar rise last year, with the European Renewable Energy index down around 25% from its January peak. But several investment banks – from Goldman Sachs to Royal Bank of Canada – think the recent selloff could present you with the perfect entry point…

Why are renewable energy stocks so attractive right now?

1) They’re cheap relative to their growth potential

The selloff has left renewable energy stocks looking cheaper than tech-heavy growth stocks – not just in Europe, but globally. And unlike tech companies that benefited from a short-term, pandemic-driven demand boost, renewable energy companies will likely see multiple decades of growth as governments increasingly phase out fossil fuels. Selloff or no selloff, that growth story is still intact.

Renewable energy stocks are now trading at a lower forward P/E than growth stocks. Source: Bloomberg
Renewable energy stocks are now trading at a lower forward P/E than growth stocks. Source: Bloomberg

2) They’re benefiting from massive infrastructure spending plans

The US president has recently set out a $2 trillion-plus infrastructure spending plan to invest in clean power and electric vehicles, and the many European renewable energy companies based over there are cleaning up. It’s the same across the pond: the European Union reached an agreement on its Green Deal in April, in hopes the bloc will reach net zero emissions by 2050. That’s no easy feat, and Bloomberg New Energy Finance predicts it’ll lead to record onshore wind builds in 2021 and 2022, and a record year for solar builds in 2021 too.

3) Investor sentiment is starting to turn (for the better)

There’s a whole host of good signs for renewable energy stocks. The European Renewable Energy index has started to bounce back, up around 10% from its May lows. Investment bank analysts are turning positive, upgrading their investment recommendations across a number of stocks. The United Nations Climate Change Conference is taking place in November, which could bring renewed focus to clean energy investments. And last but not least, there’s huge and growing investor interest in green stocks that only gets stronger every year.

How do you find the best renewable energy stocks?

There are two key things worth keeping in mind about renewable energy stocks.

First, it’s important to be patient and view them as long-term investments. If you’re looking for a quick rebound, you might be in for a disappointment. But if you’re patient enough to ride out a theme that’ll dominate for decades to come, then you’ll most likely be rewarded.

Second, some renewable energy stocks are still a bit pricey, even if their valuations have come down a bit recently. That’s why it’s important to be selective about which stocks you invest in.

To help you do that, take a look at the table below: it shows the 10 stocks that make up the European Renewable Energy index, sorted according to their combined rank of valuation and profitability.

European Renewable Energy index constituents
European Renewable Energy index constituents

Let’s just explain the table for a moment. The first metric, return on equity (ROE), tells us how well the company is spending shareholders’ money to make money. You can use ROE to determine if a business is good or not: the higher it is, the better. The second metric, forward price-to-earnings (P/E), tells us how much a stock costs relative to every dollar of forecasted profit. The lower the forward P/E, the cheaper the stock.

The table ranks the 10 stocks based on their combined ranking of ROE and forward P/E. So the stocks up top have good fundamentals and they’re cheaper than the rest.

What’s the opportunity here?

You can use the table in one of two ways. You can use it as an initial screen, dig deeper into each of the stocks at the top of the list, and make your own decisions on which look most promising. Or, if you were thinking of taking a more hands-off approach, you could, for example, passively invest in the top five stocks on the list. That way, you get some diversified exposure to the sector, while gravitating towards good businesses with cheap stocks.

And don’t forget, the best thing to do here is to take a long-term approach: investing in the stocks and forgetting about them while you ride out the renewable energy theme that, for my money, is only going to pick up pace.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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